FIFO, LIFO and Weighted Average: Choosing Your Inventory Valuation Method

When the same item enters your stock at different prices over time, your closing inventory value depends on which units you consider "still here" — the oldest, the newest, or an average. That choice — your inventory valuation method — quietly drives your reported profit, your tax, and the cost figure used in pricing. Here is what each method does and what to choose.

Why this matters at all

If prices never moved, valuation method would not matter. But they do. When you bought 100 units at ₹100 last quarter and 100 more at ₹120 this quarter, the cost of the 100 units you sell next is either ₹100 (FIFO), ₹120 (LIFO), or ₹110 (weighted average) — depending on the method. Cost of goods sold changes, gross profit changes, closing inventory value changes.

Over a quarter or a year, the cumulative effect on profit is significant — especially in an inflationary environment.

The three methods, in one paragraph each

FIFO — First In, First Out. Assumes the oldest units in stock are sold first. Closing inventory is valued at the most recent purchase prices. In rising-price periods, COGS is lower (older, cheaper costs flow out) and reported profit is higher; closing inventory is higher.

LIFO — Last In, First Out. Assumes the newest units are sold first. Closing inventory is valued at the oldest prices. In rising-price periods, COGS is higher (newer, dearer costs flow out) and reported profit is lower; closing inventory is lower.

Weighted Average. A new average cost is computed every time a purchase happens. Both COGS and closing inventory use this evolving average. Smooths the impact of price changes in either direction.

What India allows

This is the crucial constraint for an Indian business: LIFO is not permitted under Indian Accounting Standards. AS-2 (and Ind AS 2) prescribes FIFO or weighted average. You can use either of these; you cannot use LIFO for reported financial statements or tax.

So the practical choice for an Indian business is between FIFO and weighted average (moving average is the most common implementation).

FIFO vs weighted average — when each fits

FIFO fits when:

• Items have a natural physical first-in-first-out flow (perishables, fashion, dated goods)
• Cost traceability matters — you want to know exactly which lot a unit came from
• You hold relatively few SKUs with clear receipt batches

Weighted average fits when:

• Items are fungible and physical first-in-first-out is impractical (bulk materials, fluids, identical parts)
• You receive frequent small replenishments and tracking specific lots is admin-heavy
• You want smoothed cost of goods sold for stable pricing

For most Indian manufacturers and distributors, moving weighted average is the practical default — it is simpler to operate, requires less batch tracking, and gives a smoother cost.

For pharmaceuticals, perishables, and goods with dated batches, FIFO is usually mandated by the nature of the business regardless of the costing method.

Worked example

Beginning stock: nil. Three purchases and one sale:

• Buy 100 units @ ₹100 (1 Apr)
• Buy 100 units @ ₹110 (10 Apr)
• Sell 120 units @ ₹150 (15 Apr)
• Buy 100 units @ ₹120 (25 Apr)

Closing stock at month-end: 180 units. Revenue: 120 × 150 = ₹18,000.

FIFO:

• COGS for the sale: 100 @ ₹100 + 20 @ ₹110 = ₹12,200
• Closing stock: 80 @ ₹110 + 100 @ ₹120 = ₹20,800
• Gross profit: ₹18,000 − ₹12,200 = ₹5,800

Weighted average (at time of sale):

• Average cost at sale: (100×100 + 100×110) ÷ 200 = ₹105
• COGS: 120 × 105 = ₹12,600
• Closing stock after the 25 Apr buy: 80 @ ₹105 + 100 @ ₹120 = ₹8,400 + ₹12,000 = ₹20,400
• Gross profit: ₹18,000 − ₹12,600 = ₹5,400

Same physical reality. Different profit and different closing stock. Neither is "wrong" — they just answer different questions about which costs flowed out.

Consistency matters more than the choice

Whichever method you pick, apply it consistently across periods and (where possible) across items. Switching methods to flatter results in one period and then back next year is both bad management practice and likely to invite audit questions.

A genuine change of method is allowed — it needs disclosure in your financial statements, restatement of the comparative period, and a clear business reason. Don't do it casually.

The connection to pricing

The cost number your inventory method gives you is also the number that flows into pricing decisions. Two implications:

• A falling-price environment with FIFO inflates COGS in the current period (older, dearer costs flowing out) — leading to lower reported margin and potential price cuts that were not actually warranted
• A rising-price environment with FIFO understates current COGS — leading to over-stated margins and potential under-pricing

Weighted average smooths both. That smoothing is one reason most operations prefer it.

How Booksmor helps

Booksmor uses moving weighted average by default for inventory valuation (the most common Indian practice), with FIFO available where batch-level traceability is required (pharma, perishables, dated goods). Stock value, COGS and per-item average cost are visible in real time as purchases happen. Start a 30-day free trial and run your stock on the right basis from day one.